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Ruling

Subject: NCL - Commissioner's discretion - Lead time.

Question

Will the Commissioner exercise the discretion in paragraph 35-55(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow you to include any losses from your primary production activity in your calculation of taxable income for the 2009-10, 2010-11 and 2011-12 income years?

Answer

No

This ruling applies for the following periods

1 July 2009 to 30 June 2012

The scheme commenced

2006-07 income year

Relevant facts and circumstances

You purchased a property as a going concern. The property had been in a poor condition when it was purchased.

You are conducting one primary production activity with two components.

Since the farm was purchased you have spent a considerable amount of funds to improve the property.

You have employees including a farm manager to manage the property.

To reduce the expenses on wages to farm employees, you intend to reduce your work to three days per week.

You have indicated that the farm will be commercially viable in five to six years from the date you purchased the property.

You advised that you were required to make considerable adjustments to the activity to generate further income.

You previously requested the Commissioner to issue a private ruling with regards to your activity for the 2009-10 to 2011-12 income years. The Commissioner did not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the activity.

Subsequently you requested a new private ruling. Your Tax Agent explained that in the previous private ruling the Commissioner did not take into consideration the adjustments you had to make to the activity. She stated that you commenced a new activity from the date of purchase.

Therefore, you have requested the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the primary production activity for the 2009-10 to 2011-12 income years.

You did not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 in the 2009-10 and 2010-11 income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 35-55(1)(c).

Income Tax Assessment Act 1997 paragraph 35-10(2).

Income Tax Assessment Act 1997 paragraph 35-10(3).

Income Tax Assessment Act 1997 subsection 35-10(2E).

Reasons for decision

Division 35 of the ITAA 1997 applies to losses from certain business activities for the 2000-01 income year and subsequent years. Under the rule in subsection 35-10(2) of the ITAA 1997, a 'loss' made by an individual (including an individual in a general law partnership) from a business activity will not be taken into account in an income year unless:

o the 'Exception' in subsection 35-10(4) of the ITAA 1997 applies, or

o satisfy subsection 35-10(2E) of the ITAA 1997 for that year and one of four tests in sections 35-30, 35-35, 35-40 or 35-45 of the ITAA 1997 is met, or

o the Commissioner exercises the discretion in section 35-55 of the ITAA 1997.

Section 35-1 of the ITAA 1997 provides that an income requirement must be met (along with certain tests) in order to include losses from a business activity in your taxable income calculation. Where the income requirement is not met, the Commissioner may exercise discretion to allow the inclusion of the losses.

In your case you do not satisfy the income requirement in subsection 35-10(2E) of the ITAA 1997 in the 2009-10 and 2010-11 income years.

You also do not satisfy the exception in subsection 35-10(4) of the ITAA 1997 as you have received at least $40,000 of non-primary production income in the above income years.

Your primary production activity will only be potentially subject to these provisions if it is carried on as a business. The Commissioner is satisfied that your activity is carried on as a business.

Commissioner's discretion - lead time - 2009-10 and 2010-11 income years

The Commissioner may, on application, decide that the rule in subsection 35-10(2) does not apply to a business activity for one or more income years (the excluded years) if the Commissioner is satisfied that it would be unreasonable to apply that rule because:

(c) for an applicant who carries on the business activity who does not satisfy subsection 35-10(2E) (income requirement) for the most recent income year ending before the application is made - the business activity has started to be carried on and, for the excluded years:

(i) because of its nature, it has not produced, or will not produce, assessable income greater than the deductions attributable to it; and

(ii) there is an objective expectation, based on evidence from independent sources (where available) that, within a period that is commercially viable for the industry concerned, the activity will produce assessable income for an income year greater than the deductions attributable to it for that year (apart from the operation of subsections 35-10(2) and (2C)).

The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income. The note includes an example of an activity involving the planting of hardwood trees for harvest where many years would pass before the activity could reasonably be expected to produce income.

Paragraphs 77 and 78 of Taxation Ruling TR 2007/6, which discusses non-commercial business losses and the Commissioner's discretion, state:

Therefore, the phrase 'because of its nature' refers to inherent characteristics of the type of business activity being conducted by the taxpayer, which are common to any business activity of that type. These inherent characteristics must be the reason why the activity is unable to satisfy any of the tests. The discretion is not intended to be available where the failure to satisfy one of the tests is for other reasons.

The consequences of business choices made by an individual (for example, the hours of operation, the size or scale of the activity, and the level of debt funding) are not inherent characteristics of a business activity…

In the private ruling application you have accepted that in your industry the number of years before the activity becomes commercially viable is five to six years.

You purchased the primary production activity in the 2006-07 income year as a going concern. However, the activity has originally commenced at least 15 years earlier.

You stated that the property was in a very poor condition when it was purchased. Therefore you were required to make considerable adjustments.

You received a small income from the property in the year you purchased it. However, from the next year you received a considerable income.

Although you were required to make adjustments when you purchased the property, you received income from it.

The Note to paragraph 35-55(1)(c) of the ITAA 1997 states that the particular paragraph is intended to cover a business activity that has a lead time between the commencement of the activity and the production of any assessable income.

In your circumstances, although the property was in a poor condition when you purchased, you managed to receive income. Following the adjustments, the income increased.

The adjustments you have made have not prevented you from receiving any income during the first years of purchasing the property. As you are carrying on a mixed primary production activity income is also generated from other sources. Therefore, the Commissioner is not satisfied that you have commenced a new business activity when you purchased the property and made adjustments.

The business activity has originally commenced at least 15 years prior to you purchasing the property. You have stated that the commercially viable period for the industry is five to six years. Therefore, the commercially viable period has now lapsed.

You have also mentioned that unavoidable circumstances affected the area and it prevented the activity from generating assessable income greater than the deductions attributable to it within the commercially viable period.

Paragraphs 24 to 27 of the Taxation Ruling TR 2007/6 discusses the interaction between the two limbs ('Special circumstances' and 'because of its nature') of subsection 35-55(1) of the ITAA 1997. Paragraph 26 of the ruling states:

In such cases the appropriate enquiry will be whether or not the special circumstances outside the control of the operators of the business activity have meant that there is no longer an objective expectation that within the period that is commercially viable for the industry concerned the activity will satisfy a test (or produce a tax profit)

Paragraphs 55 to 58 of the Taxation Ruling TR 2007/6 further discusses 'outside the control of the operators of the business activity':

For these other kinds of events, the operators of the business activity must show that the special circumstances were outside their control. The concept of 'control' was discussed in Secretary, Department of Employment, Education and Youth Affairs v. Ferguson (1997) 76 FCR 426; (1997) 48 ALD 593; (1997) 147 ALR 295 for the purposes of subsection 45(6) of the Employment Services Act 1994. At 76 FCR 438; 48 ALD 603; 147 ALR 306, Mansfield J said:

The expression in s45(6)(a) requires that the main reason for the failure was something that the person had within that person's control. The concept of 'control' in that context is one of fact, but I think it is intended to mean something which the person could have done something about.

And at 76 FCR 438, 48 ALD 603; 147 ALR 306:

It recognises the focus of the expression upon occurrences which the person concerned could not realistically prevent.

However, if the operators of the business activity fail for no adequate reason to adopt certain practices commonly used in their industry to prevent or reduce the effects of certain circumstances, such as for example pests or diseases, then that may point to the circumstances being within their control.

Similarly, the acquisition of a poorly run but promising business activity would generally be considered to be within the control of the business operator and as such would not, by itself, constitute special circumstances, even though the actions of the former operator may have been outside the control of the current operator.

When you purchased the property, you were aware that the condition of the property was poor. The property was previously neglected. It is stated that this condition can partially be put down to unavoidable circumstances. However it was your decision to purchase the property in that state. Therefore, as stated in paragraph 58 of the Taxation Ruling TR 2007/6, it was within your control to purchase the property and as such will not constitute special circumstance in terms of Division 35 of the ITAA 1997.

We do not consider that there is anything inherent or innate in the nature of your business activity which means that it has not yet been able to generate assessable income greater than the deductions attributable to it within the commercially viable period.

As stated above, for the Commissioner to exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997, the activity should satisfy both subparagraphs (i) and (ii).

On the facts provided, the Commissioner is not satisfied that you have not received assessable income greater than the deduction attributable to it in the 2009-10 income year because of the nature of your mixed primary production activity (subparagraph (i)).

Therefore, the Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 in relation to your mixed primary production activity for the 2009-10 and 2010-11 income years.

Accordingly, it would be reasonable to apply the rule in subsection 35-10(2) of the ITAA 1997 in relation to your business activity for the 2009-10 and 2010-11 income years.

Commissioner's discretion - lead time - 2011-12 income year

In the projected cashflow statement you have stated that the activity is expected to produce assessable income greater than the deduction attributable to it in the 2011-12 income year.

Therefore, the Commissioner is precluded from exercising the discretion in paragraph 35-55(1)(c) of the ITAA 1997.

Summary of reasons for decision

The Commissioner will not exercise the discretion in paragraph 35-55(1)(c) of the ITAA 1997 for the 2009-10, 2010-11 and 2011-12 income years because, on the facts provided:

The Commissioner is not satisfied that it is because of the nature of your primary production activity that it did not receive assessable income greater than the deduction attributable to it in the 2009-10 and 2010-11 income years.

The Commissioner is precluded from exercising the discretion in paragraph 35-55(1)(c) of the ITAA 1997 as you expect to receive assessable income greater than the deduction attributable to it in the 2011-12 income year.

As you did not receive assessable income greater than the deductions attributable to it in the 2009-10 and 2010-11 income years, the rule in subsection 35-10(2) of the ITAA 1997 will apply to defer to a future income year any loss generated from your activity for those years. A deferred loss is not disallowed and will be deductible against any taxation profit from your activity, or similar business activity, in future years.

If your activity, or similar activity should satisfy an exception or satisfy the income requirement and one of the tests in Division 35 of the ITAA 1997 in any given year, then the whole of the deferred loss will be deductible in that year.